Generic take-up in the pharmaceutical market following patent expiry

Abstract

This article analyzes for the pharmaceutical market in the United States, the United Kingdom, Germany, and Japan: (a) the determinants of generic entry; (b) the determinants of the entry lag when there is generic entry; and (c) the impact on original brand sales of generic entry. The results suggest that the larger the market, the greater is the probability of both generic entry and the subsequent impact on original brand sales. These results imply that the value of a patent does not end with patent expiry, as the literature commonly assumes, and estimates of patent postexpiry values are obtained.

Introduction

What impact does patent expiry have on original brand sales in the pharmaceutical market? Despite the considerable work that has been done on pharmaceutical markets this remains a relatively unexplored area. There has been some work done on the impact of generic entry on the original brand, although this has mainly focused on the original brand’s price and market share in the United States. Thus, Hurwitz & Caves (1988) examined the impact of generic entry on market share, promotional spending, and the number of generic entrants. They found that the original brand market share is directly proportional to the age of the original brand, which they interpret as a brand loyalty variable, and to own brand promotional spending and is negatively related to entrants’ potential spending and to the number of entrants. They also found that the number of new entrants was directly proportional to the total size of the market and the age of the original brand. This latter variable figures in several other studies and would appear to be of some importance, but we feel that its interpretation as a brand loyalty variable is open to question. The youngest original brand at patent expiry is unlikely to be less than 10 years old (dating age from the date the product first registered positive sales), and it seems somewhat unlikely that there is any significant difference in the brand loyalty of, e.g., a 15-year-old brand and a 10-year-old brand. We shall later put forward an alternative interpretation of this variable that is similar to a possibility discussed by Manning (1997), who argued that it may reflect life cycle effects as new products appear on the market.

Grabowski & Vernon (1992) analyzed the impact of generic entry following the introduction of the 1984 Drug Price Competition and Patent Restoration Act (The Waxman–Hatch Act) in the United States, which facilitated the entry of generics after patent expiry while restoring part of the patent life lost during the pre-market regulatory process for new introductions. In their empirical analysis, they showed that generics entered the market at a significant price discount, which then declined steadily over time. The price of the original brand actually increased, albeit in nominal terms, in the period following generic entry. As with Hurwitz & Caves (1988), they also analyzed generic entry in terms of the number of generic products, which they linked to a profitability variable and a set of brand loyalty variables, both of which are defined at the time of initial entry. More recently, Grabowski & Vernon (1996) specifically examined the impact of the Waxman–Hatch Act. They found generic competition intensifying in recent periods, with major brand names typically losing half of their market share within a year of patent expiry. On the other hand, they also found that the provision within the Waxman–Hatch Act for patent extension lengthened the effective patent life.

Caves, Whinston & Hurwitz (1991) analyzed the impact of generic entry in several therapeutic classes in the United States. They found that the price of the original brand declines over time as more generic entrants appear. Ellison, Cockburn, Griliches & Hausman (1997) modeled demand for four cephalosporins, again in the United States. They concluded that there was a fairly high demand elasticity between generic substitutes and a smaller, but sometimes significant, demand elasticity between therapeutic substitutes, i.e., chemically distinct drugs that can be used to treat many of the same conditions. Griliches & Cockburn (1994) concentrated on the impact of generics on pharmaceutical price indices but, in the process, analyzed the diffusion of generics and the impact on the original brand’s price of generic entry.

The focus of this article is somewhat different than those just discussed. In particular, we are interested in the impact of patent expiry rather than generic entry, and we are more focused on the implications for the original brand. We shall be looking at three questions. (a) Under what circumstances does generic entry take place? (b) What are the determinants of the time lag (if any) between generic entry and patent expiry? (c) What is the impact of generic entry on the sales of the original product? These are relatively unexplored areas. For example, most analyses have concentrated on market share rather than sales. The introduction of generics may have direct effects on the total size of the market, particularly when measured in revenue terms. Hence, analyzing market shares only gives a partial picture of the impact on the original brand. This article also differs from much of the previous work in its international emphasis, analyzing not just the US market but also those of Japan, Germany, and the United Kingdom. Unlike France, for example, generics take a significant market share in all of these markets, while, unlike Spain and Italy, all have had an effective system of patent protection in place throughout the sample period. But in other respects they differ significantly both in the extent to which the markets are free from government intervention and the size of the market. Other characteristics are also very different. For example, in Germany generics appear as branded products in their own right with either a unique trademark or with the maker’s name specified, while, as has been mentioned already, in the United States the 1984 Waxman–Hatch Act facilitated generic entry by allowing generic entrants to demonstrate bioequivalence to the original brand rather than having to replicate many of the tests undergone by the original brand, as was originally the case.

In the next section, we shall briefly discuss some of the theoretical issues raised by patent expiry and generic entry. We then will discuss how the implications of this analysis are likely to differ in the contrasting market environments of the four countries. The results of the empirical work will follow, after which we will discuss some of the implications of our work for the valuation of patents. The literature on this subject typically assumes that patent benefits end with patent expiry. Our analysis emphasizes that they do not, and we obtain estimates of postexpiry patent values (PEPVs). Finally, there will be a brief concluding section.